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Estate Planning

Estate Planning. Chapter 12: Special Elections and Post Mortem Planning. Liquidity Needs. Last medical costs Adequate health insurance Funeral costs Prepay funeral during life reduces need Transition or adjustment period costs Assets going through or outside of probate

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Estate Planning

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  1. Estate Planning Chapter 12: Special Elections and Post Mortem Planning

  2. Liquidity Needs • Last medical costs • Adequate health insurance • Funeral costs • Prepay funeral during life reduces need • Transition or adjustment period costs • Assets going through or outside of probate • Outside reduces transition costs • Administrative costs • Attorney, CPAs, appraisers, executor • Income, estate and generation skipping transfer taxes • Nine months to pay

  3. Liquidity Sources and Implications (1 of 4) • Sale of assets • May not find willing buyer for what it is worth • Particularly if must be done quickly • Life insurance • Don’t forget the ILIT • Can make loans • Buy assets • But not require to pay estate taxes

  4. Liquidity Sources and Implications (2 of 4) • Tax advantaged accounts – qualified plans, IRAs • IRD – if you defer income during life then it is taxable as IRD to the heirs • If executor takes distributions from the Qualified Plan or Traditional IRA then the estate has to pay income tax on the distributions from the plan • Leave these to charity • Large amount of tax to liquidate to pay estate taxes

  5. Liquidity Sources and Implications (3 of 4) • Corporate redemption from closely held businesses • Normally dividend ordinary income • Currently capital gains tax rate • IRC Sec 303 allows shareholder to redeem enough shares to cover tax and expenses and qualify for capital gains • 35% of the AGE must be the closely held business • Multiple businesses can be combined, but one needs to be 20% of AGE • Generally no income tax due on redemption of stock due to step up in basis

  6. Liquidity Sources and Implications (4 of 4) • Distribution of assets • Assets in lieu of cash • Sale of asset by heir • Government wants CASH! • Estate recognizes any gain from date valued in estate • Loans for payments of taxes and other costs • May borrow to cover costs • Estate can deduct interest if they had to borrow.

  7. Joint or Separate Final Return (1 of 2) • Final income tax return may be filed as married filing separately or married filing jointly • Married filing jointly due to the more favorable tax

  8. Joint or Separate Final Return (1 of 2) • Surviving spouse may file as qualified widow(er) for two years following death, and enjoy the lower tax rates applicable provided that: • Surviving spouse is not remarried • Surviving spouse maintaining home for one or more dependent children

  9. Passive and Capital Losses • If the decedent had losses from prior tax years • Passive losses carried over can be claimed on the decedent’s final income tax return • Capital losses can’t

  10. Expense Elections • If the decedent’s estate is not subject to estate tax the expenses should be deducted from the decedent’s final income tax return • If the decedent’s estate is subject to estate tax then it is usually more advantageous to deduct the medical expenses from the estate tax return

  11. Income Tax Issues Regarding the Estate (1041) • Selection of tax year • Expense elections • Waiver of executor’s fees • US Savings Bonds • Distribution and tax bracket analysis

  12. Selection of Tax Year • Executor can elect to have the estate’s tax year end on the last day of any month during the year • January 31 preferred to November 30

  13. Expense Elections • If the estate is subject to federal estate taxes then it is better to deduct the expenses on the estate tax return • If the estate is not subject to federal estate taxes then an income tax deduction should be claimed on the estate income tax return

  14. Waiver of Executor’s Fees • Fees can be deducted on either (but not both) the estate income tax return or on the estate tax return • Generally estate tax return more beneficial • Generally the executor is also beneficiary and if the beneficiary receives distribution from the estate, there is no income tax consequence • An executor who is also a beneficiary of the estate should consider whether or not he would like to waive the executor’s commission • For small estates – a waiver of the executor’s fee will usually make good financial sense • Essentially making gift to other heirs

  15. US Savings Bonds • US Savings Bonds are IRD assets • Do not receive a step to FMV in basis at the owner’s death • The estate will have to pay tax on the income • Distribute the income to the beneficiaries and allow them to pay the income tax • Charitable bequests – use Savings Bonds

  16. Gift Tax Issues • Election to Split Gifts for Year of Death • Code allows a surviving spouse to elect to split the gifts made by the decedent in the decedent’s final tax year

  17. Basic Estate Planning Issues (Post Mortem) • Valuation of assets • Fair market value • Assets usually require an appraisal • Unless publicly traded • Selection of valuation date • Alternate valuation date • Can only be used if it reduces estate taxes • Not to create step up in basis at no cost

  18. Installment Payments of Estate Tax (6166, 6161) (1 of 3) • Closely held business • Extend the payment of estate taxes over a 14 year period. • First four years of payments are interest-only, followed by 10 payments that amortize the estate tax liability over the payment period • The value of the business interest must be at least 35% of the value of decedent’s Adjusted Gross Estate (AGE) • Gifting other assets can help

  19. Installment Payments of Estate Tax (6166, 6161) (2 of 3) • The business interest must be: • a closely held business (a sole proprietorship); • a partnership if at least 20% of the capital interest is included in the decedent’s gross estate or if the partnership has fewer than 15 partners; or • a corporation if at least 20% of the voting stock is included in the decedent’s gross estate or if the corporation has 15 or fewer shareholders)

  20. Installment Payments of Estate Tax (6166, 6161) (3 of 3) • The entity must have been actively engaged in the conduct of a trade or a business at the date of the decedent’s death • Interest is 2% on estate tax of $580,000 in 2014 • Remainder is at 45% of the regular underpayment rate

  21. Special Use Valuation (2032A) (1 of 4) • Fair market value implies the value of a property is its highest and best use • The value included in the decedent’s gross estate will be the current use value of the property, subject to a limitation that the highest and best use value cannot be reduced by more than $1,090,000 for 2014

  22. Special Use Valuation (2032A) (2 of 4) • Conditions for special use valuation: • Property must be used in a farming operation or trade or business that was actively managed by decedent or decedent’s family 5 out of the 8 years immediately preceding decedent’s death • Value of real and personal property used in qualifying manner must equal or exceed 50% of decedent’s adjusted gross estate (not taking into consideration any reductions for unsecured indebtedness)

  23. Special Use Valuation (2032A) (3 of 4) • The qualifying property must pass to qualifying heirs (a member of the decedent’s family who acquires the property from the decedent) who must actively participate in the farming activity or trade or business • Executor must file the election with the estate tax return, complete with a recapture agreement

  24. Special Use Valuation (2032A) (4 of 4) • Qualifying heirs must continue to use the property in its qualified use, as stated in the election included with the estate tax return for a period of at least 10 years following decedent’s death

  25. Disclaimers (1 of 2) • Must be in writing • Must be made within 9 months • Disclaimant cannot specify the party to whom the property will be transferred as a result of the disclaimer • The disclaimant cannot accept any interest or benefit in the property prior to disclaiming

  26. Disclaimers (2 of 2) • QTIP Election • Ultimate decision of whether to make the election, and, if the election is to be made, how much property should be qualified by the election, rests with the executor or administrator of the estate • Executor has 15 months to determine the applicability of the QTIP election • Making QTIP election means assets will be included in surviving spouse’s estate

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